Regular loan portfolio audits and strong legal instruments will combat the challenge of non-performing loans (NPL), and boost profitability of the financial sector, experts have said.

According to the experts, there is need to streamline the loan recovery procedures from both the supply and demand side to address the challenge.

The advice follows a report by the National Bank of Rwanda, which indicated a drop in profits for micro finance institutions, attributed to bad loans.

In fact according to statistics, NPLs for MFIs increased from 6.8% to 7.7% in December 2014 compared to the same period in 2013.

And though the situation in commercial banks improved (from 7.2% in September 2013 to 6.3% 2014 same period), there is growing debate about what exactly should be done to address the challenge.

According to Peter Rwema, the director of programmes, Association of Micro Finance Institutions in Rwanda (AMIR), there is need for strong legal instruments to be able to instill discipline in loan defaulters.

"From the meetings we have had with MFIs, it always comes back to weak legal instruments and loan recovery procedures. It’s therefore obvious that establishing a faster and well decentralised legal frame work will not only hold borrowers accountable to credit institutions but will also grow the financial sector,” Rwema told The New Times in an exclusive interview.

People must understand that when you borrow money from a credit institution, its people’s savings, you must pay back to sustain the growth of the sector and that of the economy, he added.

According to Jonathan Gatera, the National Bank of Rwanda Director General, in charge of financial stability directorate, there is need for market players to come up with clear and good loan recovery procedures to deal with the question of NPLs.

"Most challenges faced by the financial sector are created by institutions themselves; these include poor loan granting procedures, low skills in loan portfolio management and weak recovery systems coupled with financial illiteracy,” Gatera had earlier said during the launch of Letshego deposit taking services in Kigali recently.

Even Rwanda’s Minister for Finance and Economic Planning, Claver Gatete in an earlier interview with this publication acknowledged the need to encourage people to pay back.

"Even at 6.6% NPLs, it is a lot of money not being paid back, which would otherwise be going back in terms of lending. However, now that we have a credit reference bureau and with strict regulations at Central Bank, we believe these numbers will continue going down,” Gatete said .

Usually our target is 5% which we believe is normal compared to developed countries which are usually between 2-3%, Gatete added.

According to Eric Rwigamba, the director general for financial sector development at the Ministry of Finance and Economic Planning, the challenge will be best addressed through government’s financial education strategy.

While the central bank largely attributed a drop in profits to increasing NPL ratio, experts argue that other factors including expansion plans could have been at play.

"The desire to expand operations has seen most MFIs invest heavily in infrastructure and human capital which has not yet materialized in terms of returns. We are however hopeful that in the long run these expansion projects will boost the profitability of the sector, Damascene Hakuzimana, Senior manager in charge of communication and advocacy at AMIR, said.